LESSON 6

THE ORDINAL APPROACH

 OBJECTIVES
On completing the module, you should be able to:
• Discuss the Assumptions underlying ordinal approach
• Identify the Properties of Indifference Curve
• Determine Marginal Rate of Substitution
• Analyze the Budget Line
• Determine the Effects of Price Changes on the Budget
Line
•Economist following the lead of Hicks,
Slutsky and Pareto believe that utility is
measurable in an ordinal sense.

•The utility derived from consuming a

good, is a function of the quantities of X
and Y consumed by a consumer.
U=f( X, Y)

•Only reflects an order but the

difference between the numbers
assigned is meaningless.
 ASSUMPTIONS UNDERLYING ORDINAL
APPROACH
Rationality
• The consumer is assumed to be rational. He aims at
maximizing his benefits from consumption, given income
and prices.
Ordinality
• The consumer is capable of ranking all conceivable combinations of
goods according to the satisfaction they yield. Thus, if he is given
various combinations say A, B, C, D, E he can rank them as first
preference, second preference and soon.
 Diminishing Marginal Rate of Substitution:

Consistency
• It means if good X is preferred over good Y in one time, then
consumer will not prefer Y over X in another time period.

Transitivity of Choice
• If the consumer prefers combination A to B, and B to C, then
he must prefer combination A to C. In other words, his
choices are characterized by the property of transitivity.
Non- Satiation
• If combination A has more commodities than combination B, then A must be
preferred to B.
Indifference Curve (IC)
• An indifference curve is the set of all combinations of commodities X and Y that
yield the same level of total utility or satisfaction.
• It is a curve representing different baskets of goods giving the same utility to an
individual.
Indifference Map
• A set of indifference curves is called indifference map.
• An indifference map depicts complete picture of consumer’s tastes and
preferences.
• In a figure indifference map of a consumer is shown which consist of three
indifference curves.
GOOD Y

U=30
U=20
U=10

0
GOOD X
 Properties of Indifference Curve
• Indifference curves slope downward to the right: this property implies
that when the amount of one good in combination is increased, the
amount of the other good is reduced. This is essential if the level of
satisfaction is to remain the same on an indifference curve.
• Indifference curves are always convex to the origin: It has been
observed that as more and more of one commodity (X) is substituted
for another (Y), the consumer is willing to part with less and less of the
commodity being substituted (i.e. Y). This is called diminishing
marginal rate of substitution.
• Indifference curves can never intersect each other:
  A higher indifference curve represents higher level of
satisfaction than the lower indifference curve: This is
GOOD Y because combinations lying on a higher indifference
curve contain mere of either one or both goods and
more goods are preferred to less of them.

B
C

U2

U1

0
GOOD X
 Budget Line
•A higher indifference curve shows a higher level of
satisfaction than a lower one.
• Therefore, a consumer in his attempt to maximize
satisfaction will try to reach the highest possible indifference
curve.
• Butin his pursuit of buying more and more goods and thus
obtaining more and more satisfaction he has to work under
two constraints: Firstly, he has to pay the prices for the goods
and, secondly, he has a limited money income with which to
purchase the goods.
• These constraints are explained by budget line or price line.
• In simple words a budget line shows all those combinations
of two goods which the consumer can buy spending his
given money income on the two goods at their given prices.
• Allthose combinations which are within the reach of the
consumer (assuming that he spends all his money income)
will lie on the budget line.
• Line showing all combinations of items can be purchased
for a particular level of income (M); M=PxQx + PyQy
• Slopes of the budget line is Px / Py.
 Effects of Price Changes on The Budget Line

• When price of good X increases, the quantity of good X is reduced (by

maintaining the quantity of Y) & vice versa. Points on the X axis
shifted to the left (a small quantity of X)
• When the price of Y increases, the quantity Y is reduced (by maintaining
the quantity of X) & vice versa. Point on Y axis move to the bottom
(small quantity in Y)
• Changes in the price of goods Y.
Y

Py

Py

X
THANK YOU!!!